McDonald's' Consistent Above-Average Growth and Income

History

Oak Brook, Illinois based McDonald's is the leading fast food hamburger chain in the world.

According to their website, Dick and Mac McDonald founded the McDonald’s (NYSE:MCD) we know today in 1948. The famous McDonald’s french fries made their debut in 1949. In 1954 a milkshake salesman named Ray Kroc visits the California restaurant. On April 15, 1955 he opens his first McDonald’s in Des Plaines, Illinois and McDonald’s was forever changed.

In 1956 Fred Turner, future chairman, was hired and by 1958 over 100 million hamburgers were sold. In 1959 the 100th restaurant was opened in Wisconsin; by 1963 the 500th opened. Today there are between 30,000 and 35,000 McDonald’s restaurants that, according to Zacks Investment Research, operate in over 118 countries throughout the world.

Present Day

On March 8, 2010, McDonald’s announced better-than-expected February comparable sales growth of 4.8% on top of January comps rising 2.6%. Pretty good numbers for this once fast grower that has more recently become a growth and income story. Back in the early growth phase of McDonald’s' legacy cited above, rates of 30% to 50% earnings growth were common spanning decades.

One of the great benefits of our EDMP, Inc. F.A.S.T.™ Graphs (Fundamentals Analyzer Software Tool) is their ability to provide an essential fundamentals-based perspective on a company at a glance.

Figure 1 below depicts McDonald’s over the past 20 years based on earnings growth (green line with white triangles) and dividends paid out of those earnings (light blue shaded area). McDonald’s morphing from a growth stock to a growth and income stock is visually evident as the dividend payout expands greatly.

Figure 1 MCD 20yr EPS Growth (click to enlarge)

With Figure 2, we add monthly closing prices (black line) to the graph since 1991. Note how closely stock price (black line) tracks earnings. Also note that if the black price line gets disconnected, either over or under, from the green earnings line, convergence soon occurs.

Figure 2 MCD 20yr EPS Growth Correlated to Price (click to enlarge)

Figure 3 below provides a performance chart that applies to Figure 2 and includes a dividend cash flow table. A careful review of the dividend table reveals an inflection point that occurred between the period 2001 through 2004 (red shaded areas, in both Figures 2 and 3) and another from 2005 to current.

Figure 3 MCD 20yr Dividend and Price Performance (click to enlarge)

McDonald’s Dividend Policy - A Historical Perspective

As best we can determine, McDonald’s paid their first dividend in 1976. However, since they were still in a moderately high growth phase the initial dividend was minuscule regarding yield and payout ratio. An analysis of their more recent dividend policy since 1991 illustrates their evolution from high growth and modest income to moderate growth in both earnings and yield. The change in McDonald’s payout ratio tells the story.

In 1991, McDonald’s paid out approximately 15% of their earnings as dividends. This held until 2001 as their payout ratio grew to a still modest range of 15 to 20%. In 2001, McDonald’s paid out 18% and because earnings took an uncharacteristic sabbatical from growth, they did not raise the dividend for 2002.

From here on we see McDonald’s making a major change in their dividend policy. By 2003 and for 2004 the payout ratio increased to almost 28%. In 2005 it increased to 34% and by 2006 it reached 42%. By 2007 their payout ratio moved to 49% which is more typical of a dividend paying stock than a growth stock. Also, in 2008' they began paying dividends quarterly instead of only annually indicating more income orientation and less growth.

Evolution From Growth to Income

In 1965, McDonald’s went public at $22.50 per share before splits. During the 60s, 70s and 80s, McDonald’s was a quintessential growth stock. Earnings growth of 30% to 50% per year or higher and shareholder returns from capital appreciation alone that matched earnings growth were commonplace. Back then, McDonald’s allocated the vast majority of its cash flow and earnings towards funding their rapid growth.

Since the 90s (see Figure 1), McDonald’s has, as is quite common for young fast growers, slowly but steadily become a large-cap blue-chip growth-and-dividend story as it matures.

The Future

With Figure 4 and 5 below, we zoom in on the more modern McDonald’s of today and take a peek at the future with Figure 6.

Figure 4 MCD 6yr EPS Growth Correlated to Price (click to enlarge)

At the bottom of Figure 4 (red shaded area), note that McDonald’s' growth rate varies from a low of 1.5% (2005) to a high of 28.2% (2007). The five-year average growth rate is 14.4% (blue circle at the right). The PE ratio at 15.9 is average for this above-average company and the 3.4% entry dividend yield is close to what a 10-year Treasury bond offers. McDonald’s' price is also aligned with the Graham formula for fair value (approximately touching the green line with white triangles) indicating reasonableness. This is very similar to how the company was valued in 2005, the beginning of this graph.

Figure 5 below calculates shareholder performance that relates to Figure 4. Note that since McDonald’s started this period in value and ended in value (black price line touching the green line at both ends) shareholder returns and earnings growth are almost identical (see blue circles Figures 4 and 5).

Figure 5 MCD 6yr Dividend and Price Performance (click to enlarge)

Figure 6 below is a forecast calculator based on FirstCall aggregated consensus of 18 analysts. This graph implies a 9% 5-year earnings growth expectation plus a starting-at-cost dividend yield of 3.4% that should increase by 9% each year. This assumes that the 9% estimate is correct and that McDonald’s' payout ratio remains at approximately 50%.

Figure 6 MCD 5yr EPS Forecast (click to enlarge)

Conclusion

McDonald’s is, in our opinion, an excellent choice for conservative investors seeking both growth and increasing income. They have a superb balance and generate strong cash flows that support their dividend. McDonald’s possesses several avenues to support above-average growth both short and long term. We believe that current valuation is reasonable and a 3.4% dividend that could grow with earnings growth offers an attractive package. Quality, value, growth, and income makes McDonald’s a solid choice in our opinion.

Disclosure: Author holds a long position in MCD at the time of writing.

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